Do the Math: Theoretical Merchant Windfall
Merchants have been battling the various card associations for over a decade regarding the nature of debit card fees. It appears that Congress and the President have chosen sides. The Dodd-Frank Wall Street Reform and Consumer Protection Act (commonly known as the “Financial Overhaul” act) includes an amendment by Sen. Richard Durbin (D., Ill) which allows the government to regulate debit cards fees that some card-issuing banks charge merchants. In particular, the bill empowers the Federal Reserve to set rates for a lucrative fee many Associations set for the processing of signature based debit card transactions. According to various reports, merchants are in line to save up to $500 million or more should the Fed enact such price controls.
The Fed has thus far proposed two preliminary proposals which would place a fixed fee between seven cents ($0.07) and twelve cents ($0.12.) on each signature debit transaction. This is a whopping decrease when compared to current fees. Use Visa™ as an example -- they have more debit card transactions than MasterCard™. Visa’s signature debit fees roughly range between 0.62% of the purchase price plus a fixed fee of $0.13 (Visa™ “CPS/Retail Debit”) and 1.6% + $0.15 Visa “CPS/Card Not Present”)  . The proposed Fed rates are lower than both of these rates’ fixed fee portions alone, which means that the proposed scheme will affect virtually all merchants.
So what does this mean in real dollar terms? Well, a $100 internet purchase (generally covered under CPS/Card Not Present for Visa) would currently cost a merchant ($100.00 x 1.6%) + $0.15 = $1.75. This works out be almost fifteen (15) times more expensive than the proposed $.12 cap. Take the example of an Internet merchant who sells $10 MM per year with an average sale of $100.00. This, of course, works out to be 10,000 orders, of which plausible speaking, 40% are made with signature debit cards. Under current rates, this merchant would pay ($10,000,000 x 1.6%) + (10,000 x $0.15) = $175,000 + $15,000 or $175,000. In signature card debit fees per year. Under the proposed Fed provisions this merchant would pay only $12,000 – a profound 93% decrease in cost.
Payment Processors, Contracts & Bundled Rates?
The proposed rules affect the card-issuing banks, which receive the interchange, and will experience a precipitous fall in profits in their merchant businesses. But, the banks make up only part of the ecosystem which also includes merchants, the Card Associations, and very importantly, payment processors. You see, merchants rarely work directly with the banks. Instead, they go through payment processors, which tack on fees of their own for providing some important functions and some ancillary services. The proposed regulations remain silent on payment processors, which could generate two interesting problems for merchants.
1.Bundled Rates: Unfortunately, many merchants have contracted with payment processors under a bundled discount rate. That is, they pay a single fixed percentage fee or a tiered group of fixed percentage fees for signature debit transactions. These fees are usually locked in by a contract between the processor and the merchant for a fixed period of time (see Bundled vs. Pass-Through Merchant Account Arrangements on this Site.) So, under a binding agreement, merchant may still be responsible to pay their contractual fees which are based on the current rules even if the new rules take effect. The processor, on the other hand, would only be responsible for paying the banks the new proposed rates. In this case, the savings that would have gone to merchants turn into a windfall for the processor. Hopefully processors will show some good will and pass the savings along their merchants. What makes it really interesting is that many processors are owned, sponsored or controlled by the major card issuing banks! 2.Pass-through Rates: For those merchants fortunate enough to enjoy pass-through agreements with their processors, generally speaking, life should be good. These processors will simply pass along the savings. In some cases, however, things could get a bit lopsided. You see, under this scheme, the processor generally tacks on a fee of its own. Let’s say this fee is $0.07 per signature debit transaction. Under the old provisions (and using the example above), the interchange fee would be $1.75, so the processor fee is only about 4% of the total cost. Under the proposed $0.12 rule the processor fee would be approximately $0.07/$0.12 = 58%. Still, paying $0.19 where you were paying $1.75 + $0.07 = $1.82 is still a profound savings and probably not worth the aggravation of renegotiating a standing contract. But what if your fixed fee were $0.25 or higher? You would be paying the processor more than twice the debit card fee!
The Bottom Line: Be Prepared
The proposed signature debit card fees are supposed to take effect in July 2011. There are two things to consider:
1.If you are currently operating under a bundled agreement that expires prior to July, be sure to be in a god position to renegotiate. Understand the termination dates and provisions of your agreement and leverage them. For instance, some payment processor agreements require advanced notice to terminate – some up to 120 days. There may be snow on the ground, but July approaches quickly. Always consult a legal professional when pursuing contractual issues. 2.Consider promotions that will steer greater numbers of your customers to use their debit cards. The new rules only affect debit cards, but debit cards make up a large percentage of the overall cardholder universe. Be advised, however, that many acceptance and processor agreements restrict these activities, and you must consult a legal professional before taking any actions regarding steering.
Anything can happen between now and July. The proposed rules are currently open for comment. Lobbyists are working hard on both sides. There is a new, more conservative congress in session. The fact that this is a business vs. business debate could make for some very unusual wrangling in the halls of congress as well as at the Fed. So, set your Google alerts, stay on top of the news, and as always, keep an effective dialog going with your processor.
 Visa U.S.A. Interchange Reimbursement Fees - October 2010